Tax Law Stimulus

By John Lounsbury On Dec 20, 2010

A summary of the new tax law provisions was posted at the GEI News Blog as the law was being signed by the president Friday. The outline was presented courtesy of the FPA (Financial Planning Association). The economic impact of the new tax law will be subject to careful scrutiny and analysis in the coming days. GEI offers here some first pass estimates on the stimulative effects of the law. The excerpts in each section are from the previously posted FPA highlights.

Two-year extension of all current tax rates through 2012

Rates remain 10, 25, 28, 33, and 35 percent

2-year extension of reduced 0 or 15 percent rate for capital gains & dividends

2-year continued repeal of Personal Exemption Phase-out (PEP) & itemized deduction limitation (Pease)

Capital gains and dividend rates remain at 0 or 15 percent

This is basically no change from the tax law in place in 2010 so the stimulative value is largely positive only by not being negative, as it would have been to return to pre-2001 levels. CBO (Congressional Budget Office) Director Douglas Elmendorf has estimated (see Menzie Chinn) that the cumulative impact on GDP of these provisions in 2010-2015 would be between $20 billion and $80 billion. An estimate from Moody’s puts the GDP benefit at $60 billion. As a first pass, using the Moody’s number, the impact on GDP in 2011 is $30 billion. This is not additional GDP, it is preserving GDP that would have been lost had the Bush tax cuts expired.

The cost of the tax cut extension totals $207.5 billion, or just under $104 billion for each 2011 and 2012.

Temporary modification of Estate, Gift and Generation-Skipping Transfer Tax for 2010, 2011, 2012

Higher exemption, lower rate. The legislation sets the exemption at $5 million per person and $10 million per couple and a top tax rate of 35 percent for the estate, gift, and generation skipping transfer taxes for two years, through 2012. The exemption amount is indexed beginning in 2012. The proposal is effective January 1, 2010, but allows an election to choose no estate tax and modified carryover basis for estates arising on or after January 1, 2010 and before January 1, 2011. The proposal sets a $5 million generation-skipping transfer tax exemption and zero percent rate for the 2010 year.

Portability of unused exemption. Under current law, couples have to do complicated estate planning to claim their entire exemption. The proposal allows the executor of a deceased spouse’s estate to transfer any unused exemption to the surviving spouse without such planning. The proposal is effective for estates of decedents dying after December 31, 2010.

Reunification of estate and gift taxes. Prior to the 2001 tax cuts, the estate and gift taxes were unified, creating a single graduated rate schedule for both. That single lifetime exemption could be used for gifts and/or bequests. The proposal reunifies the estate and gift taxes. The proposal is effective for gifts made after December 31, 2010.

As noted above. the look-through of RIC stock held by non-resident decedents is extended through 2011.

Exemption amount indexed for inflation in 2012.

The costof the new estate tax totals $68 billion, $34 billion for each 2011 and 2012 compared to the pre-2001 exemption of $1 million with a 55% top tax rate. If we compare to 2010 when there was no estate tax (but there was also no step up in basis for heirs), the law might actually yield more tax revenue than in 2010. In addition, the author has not found any multiplier or stimulus estimate. For estimating purposes the multiplier will be assumed to be the same as for income taxes (0.29). Thus the estimate is that a reduction in GDP of $10 billion will be realized in each 2011 and 2012.

Because the dollars are small and the direction and magnitude of the revenue change from 2010 to 2011 so uncertain, this first pass estimate will ignore this as a source or removal of stimulus.

AMT Patch for 2010 and 2011

Increases the exemption amounts for 2010 to $47,450 ($72,450 married filing jointly) and for 2011 to $48,450 ($74,450 married filing jointly). It also allows the nonrefundable personal credits against the AMT.

The cost of the new estate tax totals $137 billion, approximately $68 billion for each 2011 and 2012. Since this is an extension of the tax law from 2010, it provides no additive to GDP. Without this provision using the multiplier estimate from Moody’s indicates that GDP would have decreased by about $32 billion for each 2011 and 2012.

Extension of “tax extenders” for 2010 and 2011, including:

Tax-free distributions of up to $100,000 from individual retirement plans for charitable purposes

Above-the-line deduction for qualified tuition and related expenses

Expanded Coverdell Accounts and definition of education expenses

American Opportunity Tax Credit for tuition expenses of up to $2,500

Deduction of state and local general sales taxes

30-percent credit for energy-efficiency improvements to the home (IRC section 25C)

Exclusion of qualified small business capital gains (IRC§1202)

Costs and multiplier factors for these items have not been located.

Temporary Employee Payroll Tax Cut

Provides a payroll tax holiday during 2011 of two percentage points. Employees will pay only 4.2 percent on wages and self-employed individuals will pay only 10.4 percent on self-employment income up to $106,800.

This is a biggie. The total cost in 2011 is $112 and the Moody’s estimate for the multiplier is 1.29, giving a GDP adder for 2011 of $144 billion.

Expanded Child Tax Credit, Earned Income Credit and Marriage Penalty Relief

Marriage penalty relief ($27 billion)

Expanded dependent care credit

Child tax credit ($90 billion)

Earned income tax credit

Some of these factors are actually overlapping, in the author’s opinion. For example, the child tax credit and the earned income tax credit are probably the same thing, if not completely then in large part.

These tax provisions have different multiplier estimates. The marriage penalty relief should have the same multiplier as the tax rate extension in the first section. The GDP impact would therefore be about $4 billion for each 2011 and 2012.

The child tax credit would have multiplier about 1.02 according to Moody’s, so the impact on GDP would be about $48 billion per year (2011 and 2012).

Both of these would not be adders to 2010 GDP. The absence of these provisions would have provided a reduction in GDP for each 2011 and 2012 of $52 billion.

Education Incentives Extended Through 2012

Expanded Coverdell accounts and definition of education expenses

Expanded exclusion for employer-provided educational assistance of up to $5,250

Expanded student loan interest deduction

Exclusion from income of amounts received under certain scholarship programs

American Opportunity Tax Credit of up to $2,500 for tuition expenses

Costs for these total $18 billion; multipliers for these items have not been located. These are extension of 2010 programs and should not have any significant impact on changing GDP, although the passage may have avoided a GDP subtraction. If we assume the same multiplier as for income taxes, the GDP reduction avoided is about $3 billion each year (2011 and 2012).

Extension of Certain Expiring Provision for Individuals through 2011

Above-the-line deduction for qualified tuition and related expenses

Tax-free distributions of up to $100,000 from individual retirement plans for charitable purposes. Donors may treat donations made in January 2011 as if made in 2010.

30-percent credit for energy-efficiency improvements to the home (IRC section 25C)

Deduction of state and local general sales taxes

Parity for employer-provided mass transit benefits

Contributions of capital gain real property for conservation purposes

Deductibility of mortgage insurance premiums for qualified residence

Estate tax look-through of certain Regulated Investment Company (RIC) stock held by nonresidents for decedents dying before January 1, 2012

Above-the-line deduction for certain expenses of elementary and secondary school teachers

Costs are estimated to about $7 billion. No multiplier estimate has been found. The change from 2010 is probably not significant and the GDP loss if not extended would probably be small in the grand scheme of things ($1 billion per year?).

Temporary Extension of Investment Incentives

Extension of bonus depreciation for taxable years 2011 and 2012

Small Business Expensing: increase in the maximum amount and phase-out threshold under section 179. Sets the maximum amount and phase-out threshold for taxable years 2012 at $125,000 and $500,000 respectively, indexed for inflation. (Previously-passed legislation raised the 2010 and 2011 max amount and phase-out at $500,000 and $2,000,000 respectively.)

Costs are estimated to about $53 billion. The Moody’s estimated multiplier is only 0.27, so the GDP benefit is about $7 billion for each 2011 and 2012. This is not an adder to 2010 GDP but what would have been subtracted if the tax law had not been enacted.

Extension of Certain Expiring Provisions for Businesses through 2011

Enhanced charitable deduction for corporate contributions of computer equipment for educational purposes

Enhanced charitable deduction for contributions of food inventory

Enhanced charitable deduction for contributions of book inventories to public schools

Special rule for S corporations making charitable contributions of property

15-year straight-line cost recovery for qualified leasehold improvements

Employer wage credit for activated military reservists

Tax benefits for certain real estate developments

Extension of expensing of environmental remediation costs

Treatment of interest-related dividends and short term capital gain dividends of Regulated Investment Companies (RICs)

Work opportunity tax credit (WOTC)

100% Exclusion of qualified small business capital gains held for more than 5 years (IRC§1202)

Research credit

Qualified Zone Academy bonds

Costs and multiplier estimates have not been located.

Extension of Unemployment Insurance

The unemployment insurance proposal provides a one-year reauthorization of federal UI benefits.

The cost of this is $53 billion, all in 2011. The estimated multiplier is 1.64 so the GDP adder is $87 billion. As in many other cases this is not an adder to 2010 GDP, but what would have been subtracted had the benefits not been extended.

Other/Unidentified

There remains about $30 billion in lost 2010 tax revenue that has not been accounted for in the above analysis. See table next section. If we assign the income tax multiplier to that, each of the nest two years will see a GDP effect of about $4 billion. We will assume that is loss of GDP prevented, and not added GDP.

GEI First Pass Estimate of Effects of 2010 Tax Law

Click on table for larger image.At the end of 2011 it is the very preliminary estimate from GEI that tax revenues of approximately $554 billion will have been foregone and GDP growth will have benefited by $368 billion. Of course the tax revenues may in fact be reduced by less than $554 billion if the economy grows. And of course GDP may not grow as projected.

However, the above caveats aside, an oversimplification of the preliminary estimates states that we might be increasing the national debt by $554 billion and gaining only $368 billion in additional economic activity. Based on these preliminary estimates GDP should be about 1.6% higher than in 2010. That could mean GDP growth for 2011 around 4%.

If there had no been tax law the GDP hit for 2011 could have been about 0.9% and GDP for 2011 could have been around 1.5%.

The above projections are based on the current GDP growth rate about 2.5% as a base line.

In return for the GDP boost the national debt will be increased by about 4% in 2011 over what it would have been with no tax law. That projection assumes, of course, that the GDP growth rate did not take a bigger hit with the reduced and withdrawn stimulus. If there turned out to be a return to recession, tax revenues would take a hit and the deficit would almost certainly increase at a faster rate in that eventuality.

Considering the possibility that another dip into recession could be the alternative, the loss of nearly $190 billion in the path pursued might be a cheap cost compared to another recession which could well trigger a deep depression.

There are those who will debate my proposition above, but I will stand with it until I see better data.

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